What Is an Annuity? How It Works and What to Watch For

An annuity is a contract with an insurance company. You hand over money, and in return the company pays you an income, often for the rest of your life.

How it works

Example. At retirement you hand over $100,000. The insurance company agrees to pay you a set amount every month for as long as you live. Live a long time and you may receive far more than you put in. Die early and you may receive less, unless the contract says otherwise.

Why people like them

Predictability. A pension-style income that arrives whatever the stock market does removes one large worry from retirement. For someone without a workplace pension, that can be worth a lot.

What to watch for

• Your money is usually locked up. Taking it back early often triggers a surrender charge, sometimes for years.
• Fees can be high and hard to see. Ask for every fee in writing, as an annual percentage.
• Products vary enormously. Fixed, variable and indexed annuities behave very differently. The word on the front tells you little.
• The guarantee is only as strong as the insurer. Check the company, not just the brochure.
• Commission. Annuities are often sold rather than bought. Ask the seller how they are paid on this product.

What this means for you

• Never sign at the first meeting. A good product will still be there next week.
• Ask for the fees and the surrender schedule in writing.
• Illinois residents can ask the Illinois Department of Insurance about any annuity sold in the state, free.

Where to check this yourself

Every source below is free, independent and is not selling you anything. If a source is selling you something, treat it as an advertisement, not as education.

• Consumer Financial Protection Bureau - U.S. government agency. Plain-English answers on mortgages, credit cards, loans and debt collection.
• Investor.gov (U.S. Securities and Exchange Commission) - investing basics, a free compound interest calculator, and a background check on anyone offering to manage your money.
• FINRA - oversees U.S. brokers. Clear explainers on bonds and annuities, plus BrokerCheck.
• MyMoney.gov - the U.S. government starting point for financial education.
• Federal Reserve Economic Data (FRED) - the source of the rates at the top of our Money Matters page.
• HUD-approved housing counselling - free, government-approved help for buyers and homeowners.
• Illinois Attorney General - consumer protection and scam alerts for Illinois residents.
• Illinois State Bar Association - free public guides on wills, probate and estates in Illinois.
• Illinois Department of Insurance - questions and complaints about annuities and insurance sold in Illinois.
• Internal Revenue Service - the rules on retirement accounts and what is taxable.